Sale and leaseback

An enterprise sells the property it uses to carry out its business to a special purpose vehicle set up by a bank or other financial institution. Concurrently with the sale, the property is leased back to the seller on the basis of a lease, tenancy or leasing agreement [leasing]. The entrepreneur that has sold its property must then pay rent and cover all costs connected with the property (including property tax, perpetual usufruct fees, insurance premiums, and day-to-day maintenance expenses), but gets up front cash that it can use to finance its day-to-day business activity or future investments. The financing party (the buyer of the property) becomes the owner of property, which instantly generates revenue in the form of rent. When compared to debt financing, the sale and leaseback transaction has a number of advantages. Firstly, the sale proceeds are comparable to the actual value of the real estate, whereas a loan secured by a mortgage usually only represents part of the property's value. The cost of raising money through a sale-and lease-back transaction is usually lower, as the risk assumed by the financing party is smaller. If the entrepreneur fails to perform its obligations, the financing party can terminate the lease, tenancy or leasing agreement and sell or lease the property to another entity.

Two basic models

There are two basic models of sale and leaseback transactions. In the first one, the enterprise selling the property leases it back without the right to repurchase in the future. The enterprise's only right is to use the property for the term specified in the agreement. The rent payable covers the new owner's on-going costs of obtaining finance to purchase the property and profit. In the second model, known as a classical lease back, the entrepreneur sells the property and leases it back, and has the right to repurchase it when the term of the lease expires. The rent paid to the new owner covers not only the costs of financing and the profit margin, but also repays part of the property's value. The right to purchase the property for a decreased price is usually guaranteed under a preliminary property sale agreement which is disclosed in the land and mortgage register and is therefore binding on any future purchaser of the property.

Protection of the seller's interests

As stated above, the sale and leaseback transaction generates a smaller risk for the financing party than a credit or loan secured by a mortgage on the property. However, it should be considered whether the entrepreneur selling the property to the financing party is exposed to an increased risk. As it carries out its business activities using the property subject to the sale and leaseback agreements, if the entrepreneur loses the right to use the property, it may go bankrupt or have to liquidate its business. To properly protect the entrepreneur's interests, the property is sold to a special purpose vehicle that has no employees and carries out no activity other than leasing the property to the entrepreneur and, as a rule, contracts for no liabilities other than the credit/loan for financing the purchase of the property. The entrepreneur's interests are also protected under the lease, tenancy or leasing agreement. These agreements are for a fixed period of time without the financing party (the owner of the property through the SPV) having the right to unilaterally terminate before the end of the term of the lease if the lessee is in compliance with the agreement. A lease (tenancy) agreement is concluded with signatures authenticated by a notary and recorded in the land and mortgage register kept for the property and is, therefore, binding on any subsequent owner of the property, who assumes all the rights and obligations of the previous owner.

Several leases instead of one

A difficulty related to sale and leaseback transactions is that, whereas concluding sale and leaseback agreements for at least 20 or 30 years is economically justified, under the Polish Civil Code an agreement to lease property for a fixed term longer than 10 years is deemed to be concluded for an indefinite period of time after 10 years have lapsed. One market practice used in order to remove the risk of the agreement being terminated after 10 years is to conclude several lease agreements for subsequent 10-year periods at the time the property is sold. Depending on the circumstances, other solutions may also exist. Similar issues arise for a tenancy agreement which may be terminated at any time after it has been in force for 30 years. A sale and leaseback structure is not often a beneficial way for financial institutions, particularly banks and insurance companies, to obtain funds. The services provided by these institutions are not subject to VAT, whereas VAT is charged on the rent paid for using property. Consequently the VAT paid on the rent cannot be recovered and is charged to the costs of day-to-day activities, which therefore increases the costs of obtaining financing. The costs of disposing of the property, in particular the tax on civil law transactions payable on the sale of property (2% of the value of the land sold), currently limits the economic feasibility of sale and leaseback transactions. However, once the sale of land becomes subject to VAT on 1 May 2004, the sale of land between entrepreneurs will no longer be subject to the tax on civil law transactions, and the buyer will be able to recover the VAT paid on the purchase of land. This will lower the costs of the transactions.

Pierre Gromnicki, partner - head of the real estate department

Wojciech Koczara, Legal Advisor in real estate department

at Janicka-Sosna, Namiotkiewicz i wspólnicy

Clifford Chance